Adjustment behaviour of capital structure over the business cycles: evidence from the construction industry of Taiwan

Abstract

Prior studies have found that firms may deviate from the target capital structure in the short run and adjust towards the target in the long run. However, little attention has been given to the adjustment behaviour of capital structure in the construction industry over the business cycles, in particular within the context of emerging markets. The partial adjustment model with the GMM (i.e. generalized method of moments) estimation is used to examine the adjustment behaviour of capital structure in the construction industry within the context of Taiwan during the period 1982 to 2007. The results suggest that, first, the average rate of adjustment is 26.3% of the adjustment gap between the target debt ratios and the previous debt ratios for firms in the construction industry of Taiwan. However, the average rate of adjustment towards the target debt ratios has slowed down after the Asian financial crisis of 1997. Secondly, firms with the financial constraint of over‐leverage relative to the target debt ratios have lower debt ratios than those firms with the financial constraint of under‐leverage. In addition, the difference in debt ratios between firms with the financial constraint of over‐leverage and under‐leverage has become narrower after the Asian financial crisis. Lastly, the findings suggest that macroeconomic conditions do not have a significant, negative effect on debt ratios.

Keywords:

• Capital structure
• financial constraint
• macroeconomic conditions
• construction industry
• Taiwan

Acknowledgements

The author is very grateful for the helpful comments of the anonymous referees of Construction Management and Economics, and the comments and suggestions from the anonymous referees and the participants of the 13th Construction Engineering and Management Conference, July 9, 2009, Pingtung, Taiwan.